Although it acknowledged the slowdown in the economy by slashing its gross value added growth forecast to 6.7% in 2016-17 from the earlier 7.3%, the Reserve Bank of India (RBI) on Wednesday refrained from offering any relief.

RBI Governor Urjit Patel.

Although it acknowledged the slowdown in the economy by slashing its gross value added growth forecast to 6.7% in 2016-17 from the earlier 7.3%, the Reserve Bank of India (RBI) on Wednesday refrained from offering any relief.

The central bank left the key repo rate unchanged at 6% but freed up liquidity trimming the statutory liquidity ratio by 50 basis points (bps) to 19.5%. Having anticipated a more dovish stance, the bond markets sold off, driving up the yield on the benchmark 10-year bond to a near five-month high of 6.7%.

“The loss of momentum in Q1 of 2017-18 and the first advance estimates of kharif foodgrain production are early setbacks that impart a downside to the outlook,” the RBI said in a statement.

The neutral stance was attributed to a possible rise in inflation from its current level to 4.2-4.6% in the second half of FY18. The central bank said the monetary policy committee (MPC) had taken note of a 2-percentage point rise in CPI inflation since its last meeting in August. RBI governor Urjit Patel cautioned against an expansion of the fisc, pointing out the combined deficit was at around 6%. “Our national fiscal stance can hardly be described as tight,” Patel said.

The RBI said that although the domestic food price outlook remained largely stable, momentum was building in prices of items excluding food, especially emanating from crude oil. “The MPC also acknowledged the likelihood of the output gap widening, but requires more data to better ascertain the transient versus sustained headwinds in the recent growth prints,” the central bank noted.

Patel told reporters that a faster-than-expected rise in input costs and lack of pricing power may put pressure on corporate margins, thereby affecting value added by industry. “We expressed concern about a loss of momentum of growth in Q1 2017-18, especially the persisting weakness in manufacturing,” Patel added.

The central bank added the implementation of the goods and services tax so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. “This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates,” the statement explained.

DK Joshi, chief economist at Crisil, said that going ahead, if the risks to growth rise, and inflation undershoots the MPC’s forecast, then there is a possibility of a rate cut. “The second-quarter GDP data will be a key deciding factor,” Joshi said.

The RBI also said that an internal study group has observed that internal benchmarks such as the base rate/marginal cost of funds based lending rate (MCLR) have not delivered effective transmission of monetary policy. The study group has pointed out that apart from arbitrariness in calculating the base rate/MCLR and spreads charged over them, the base rate/MCLR regime was also not in sync with global practices on pricing of loans. It has, therefore, recommended a switchover to an external benchmark in a time-bound manner.

While the MCLR regime was introduced in April 2016 for better transmission of policy rates into bank lending rates, a large section of borrowers — existing borrowers — have been left untouched. The new regime was introduced only on fresh loans and existing borrowers have to pay a fee to move their loans from base rate to MCLR. It is estimated that around half of the total bank loans are yet to migrate to the MCLR system.

However, banks argue that they have passed on more in the form of lending rate cuts than the RBI’s policy rate cut. For instance, the central bank has lowered the repo rate by 200 bps since January 2015 and public sector lender State Bank of India (SBI) has cut its lowest lending rate by 200 bps to 8% (one-year MCLR as of October 2017) from 10% (base rate as of January 2015).

SBI chairman Arundhati Bhattacharya had told FE after the August monetary policy, “I don’t think there is much scope for reducing lending rates much further. At SBI we are low enough and have already dropped rates by 175-200 bps.”